Recently there’s been a lot of excitement surrounding the dollar’s imminent demise after it slipped materially last week during Treasury Secretary Yellen’s visit to China.
We believe that this may have set into motion some interesting dynamics that could present a swing trading opportunity.
We don’t believe that the dollar is set to die anytime soon. If anything, the recent weakness may afford us a potential opportunity that arises out of some extremes in positioning dynamics that make the greenback particularly attractive vs the euro.
First, options positioning has hit an extreme. This gives us cause to watch the dollar for signs that downward momentum is beginning to slow.
We believe that process may be starting, and we may settle around 98.22. That would be our ideal area of interest for the risk-to-reward dynamic we’re looking for from this trade.
If that additional downside plays out, then fading the EURUSD by taking a short against the currency pair or going long an ETF like UUP that is largely a proxy for shorting EURUSD are both potential positions that could express this idea. UUP diagonal call spreads could be an interesting way to play this through the options market as well.
Positioning in the EURUSD pair is at an extreme for longs right now, which tells us that there isn’t likely a lot more buying to do here. At the same time, dollar short positioning has also hit an extreme.
We’re not looking for a big rally in the dollar, but we are looking for a pop back to about 103.61, with a stop out at 97.6.
Ideally this would mean taking 62 cents of risk for what could be $5.39 of reward at the index level. The trade time horizon would be about three months. If it hasn’t materialized or isn’t trending close to our target by then we would close it.
We would consider adding to this position leading into the Fed meeting on July 26th assuming that we get the downside we are looking for first.
If there is a potential catalyst for some upside in the greenback, that meeting could provide it as the Fed is not only likely to hike, but they may still project a second hike if the data warrants it, and that could give rates and dollar cause to rise.
Stronger than expected economic data also gives cause for the 10-year note yield to run higher based on the Citigroup Economic Surprise Index vs 10-year note bond yield.
If that’s the case, then we may see the 10-year yield also act as a buoy. It hasn’t had that impact of late, suggesting that either the relationship is beginning to break down and longer term rates no longer matter for the dollar (which isn’t very likely) or there is some degree of pent up elastic tension that may need to be released with the dollar having some unrealized upward potential.
We favor the latter scenario as we do feel that rates still matter for determining a currency’s strength or weakness.
Let us know your thoughts and questions. We will be sharing many more swing trading and investing ideas in the weeks and months to come.
Love this idea. Nice risk/reward. Alerts set.